Revenue Ruling 77-479
Recapitalization Prior to IPO
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Recapitalization
IPO
Initial Structure
2
1
Indiv.
A
25,000
Shares
Voting
Common
25,000 Shares
Nonvoting
Preffered
Each
Corp Z
Indiv.
B
25,000
Shares
Voting
Common
Indiv.
A
Issuance of
New Common
Shares
Indiv.
B
Cash
Indiv.
A
Indiv.
B
Common
Shares
Common
Shares
Corp Z
Surrender all
Common and
Preferred Shares
Surrender all
Common and
Preferred Shares
Corp Z
3
Public
80% of
Common
Shares
(sold thru
a broker)
Individuals A and B each owned one half of each class of the outstanding stock of Z corporation, which consisted of 50,000
shares of voting common stock and 50,000 shares of nonvoting preferred stock. Under a plan to offer some of the Z stock to
the public, A and B made arrangements with an investment broker for a secondary offering of 80 percent of their stock. To
facilitate the sale by making the stock a more attractive investment, the broker suggested that the existing common and
preferred stock be converted into one new class of common stock. Thus, Z effected a recapitalization in which all of its
outstanding shares of common and preferred stock were exchanged by A and B for shares of one new class of voting
common stock of Z on a share-for-share basis. A and B each then sold 40,000 shares of the new voting common stock to
the public through the broker.
Since continuity of interest is not required for the recapitalization of Z to qualify as a reorganization described in section
368(a)(1)(E), the subsequent sale by A and B of the stock received by them as a result of the recapitalization does not affect
the qualification of the transaction as a reorganization under section 368(a)(1)(E). Therefore, no gain or loss is recognized to
A or B on the exchange of their common and preferred Z stock for new Z common stock pursuant to section 354(a). The
basis to A and B of the new common stock is the same as the basis of the Z common and preferred stock exchanged
therefor pursuant to section 358(a). Any gain realized or loss sustained by A or B upon the sale of the new Z stock to the
public is recognized to them pursuant to section 1001.
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